Economics

The euro crisis

Going, going, gone?

SO MUCH of modern finance is a confidence game. Banks borrow short and lend long. A perfectly solvent bank can therefore go bust if depositors panic and rush to pull money out. This is why modern financial systems have backstops, despite the moral hazard cost; in their absence, the economy is at risk of irrational destruction.

European leaders have been playing their game with Greece like confidence doesn't matter. They have behaved as if an adjustment is necessary, and the only question at issue is which side will bear its costs. But confidence matters. As time has gone on, markets have become less sure of the talk that Greece would never be allowed to leave the euro area. The euro zone's chief leaders have been more concerned about moral hazard than this confidence dynamic. We know what happens in such cases; the lack of confidence destroys the system.

The slow hiss of capital leakage has been a problem for Greece since relatively early on in the crisis. That problem seems to have intensified significantly in the wake of the recent election. From May 6th to May 15th, for instance, Greeks were yanking deposits from their banks at a clip of approximately €700m per day. Why wouldn't they? If everything turns out all right, they can simply put their money back in the bank later. If Greece tumbles out of the euro area, well, they have protected their savings from huge losses. A bank run is the logical development.

The question is how long this can continue. Greece has no money. Revenue collections are falling short, and one suspects Gresham's Law may begin operating. One doesn't turn over precious euros to the Greek government if an exit is looming; one hoards them, bringing forward the day when an alternative scrip begins circulating. The mere prospect of bad money may drive out good money. Meanwhile, the flow of euros into depositors' hands ultimately originates at the European Central Bank, and the ECB is no doubt very nervous about continuing to supply them for fear of huge, open-ended exposure to a Greece that is potentially on its way out. The ECB may already be rationing euros to Greece. If that continues or scales up, we are then talking about effective capital controls—the ATMs no longer dispense euro notes—and more pressure for the introduction of alternative scrip in Greece. Exit, in other words, becomes a fait accompli.

The debate over whether or not Greece ought to leave then becomes moot. It is becoming harder and harder, of course, to argue that Greece should stay. Leaving won't spare the Greeks austerity; they still run massive budget deficits. But macroeconomic adjustment without depreciation looks increasingly difficult; it will mean more hardship and perhaps a lot more. Greece has already been in severe recession for four years. How much more can it take? How much more should it take?

That said, there are two very strong arguments against departure. One is the threat of contagion. I have no confidence that the euro area's core leadership is prepared to take appropriate steps to convince markets that no other economy will be allowed to go. In the absence of such aggressive preparation, the ECB will be the only potentially credible buffer against broad contagion and break-up. Just how much is the ECB willing to do to hold everything together? Who believes that the ECB will step into the breach and provide unlimited guarantees to peripheral economies when the worst happens (and when core governments are unwilling or unable to provide such support)? So, one very real danger is that a Greek departure will lead directly to an extremely disruptive and costly euro-zone break-up.

The other threat is that a Greek exit will lead to a failure of the Greek state. The political situation is already chaotic and will become much more so in the event of departure. If a broken political system can't manage to improve tax collection or reform public finances (and who imagines these things will improve in the near future?) then covering the government's obligations will require money printing. That will lead to a devastating hyperinflation that will only exacerbate the political dynamic. Greece will become a ward of...someone, the IMF perhaps. Should this dynamic develop, things will very clearly not be better for the Greeks outside rather than inside the euro area.

But again, potential costs may not matter; the outcome may have already been determined. I feel the need to close by saying that there is still time for the troika to get ahead of the problem, restore confidence, and put Greece on a path to continued membership in the euro area. It will take commitments and courage unlike anything we've yet seen. It will take a German leadership willing to demonstrate that they want Greece in, moral hazard be damned. I'm not sure the German leadership is capable of such things.

The greek situation is like discovering your 18 year old son has borrowed a million euros from a bank. Of course you would be furious with your son for borrowing the money. Soon after the anger comes the disbelief that any bank would be stupid enough to lend an 18 year old a million euros.

"But he told us he earned 5 million euros a year" the bank may say.

"Ha! and you believed him?!" would be your retort

Anyone you knows Greece's history of default knows that lending Greece this amount of money is exactly like lending a million euros to an 18 year old.

Why did the money get lent to Greece? Because it was being spent on german imports e.g. check who built the Athens metro.

I am German and have been lving in Thailand since 1996. I left Germany, because Ihave been critcal about Germeny since 1961, the first time I went abroad - to the UK. It is not long ago that Germany was labelled the 'sick man of Europe' also by the Economist.
Now there is a finger pointing going on blaming Germany for her surplusses and inferring that her success is the cause for other nations' problems.
Having said that, I have problems, though, with Mrs Merkel and her crew propagating the fallacy of a Bruening style solution that failed to solve Germany's problems in the aftermath of Versailles. How will an austerity program for troubled countries like Greece that once failed for Germany solve the issues at hand?
Yet, there was once a voice from France to the tune of 'the agreemnts of Masstricht, Nice and Lissabon are a Versailles without having fought a war for it'.
Such an attitude is un-European and so is Mrs Merkel's stance, however, it is also un-European to solve problems at the expenses of Germany, at the expenses of the hard work by Germans since 1945.
Mind you, the Eurozone debt crisis was triggered by a Wallstreet triggered financial crisis obliging national governments in Europe bailing out the banks.
Similarities to a financial crisis back in the late 1920ies started in Wallstreet as well?
I am afraid so, however, I do not hope so.

If there is no intenational law， a simple solution is invade the greece， take everything greeks have and sold for repaying their debts.
Why hardworking people like germans are dragged down， while lazy greeks are rewarded and spoiled.
EU had already lent them 370billions ，why give them mercy when they never willing to pay！
Greeks just chill and enjoy 14 months salary and bonus， we should kick them out long before this article

Why are you punishing us with your CAPS and bad grammar/spelling. Your argument is without logic. Seriously? blame Germany. They are the ones bailing the Greek nation out. The people of Greece need to step up and take responsibility for their OWN finances. You need to live within your means and the people of Greece need to pay their taxes, its their civic duty.

But that is precisely what was agreed at Maastricht, that we are NOT responsible for funding Greece. I'm Irish, so I understand where you are coming from, but it flies in the face of the original treaty.

Everyone is looking for Germany to 'save Europe' by, well, doing SOMETHING. But do what? Well, that's the hard part. Greece is bankrupt, it can't balance its budget (and in fact never has), and most critically, is woefully uncompetative. Most people realize that Greece can't stay in the Euro area as currently constituted. But a Greek exit not only doesn't help Greece all that much, it also doesn't solve the regions other problems. Greece, like the other heavily indebted, uncompetative, southern European countries, needs a much weaker currency to get itself out of the current mess. But a weak country leaving the Euro (either voluntarily or involuntarily) is bound to be a disaster. But a strong country (or countries) leaving the Euro? That's a totally different situation. As a general rule, strong countries have a much easier time controlling their fate than weak countries. Germany, maybe with a couple other stronger economies, could credibly leave without creating a huge mess. The Euro would depreciate massively allowing the southern Europeans to become more competative but without the mess of trying to redenominate everything against the howls of creditor protests. In contrast, creditors of northern Europe would clamor to be redenominated in a new 'Franc Mark.' The new Franc Mark would appreciate of course, but they could soft peg it to a basket of currencies and pledge to print unlimited Franc Marks to keep it from appreciate too far against, say, the Dollar, Yen and Pound a la Switzerland. It wouldn't pretty, but Germany volunatarily leaving the Euro would be the most helpful thing the Germans could do for Greece, Italy, Spain, Portugal et. al.

"The old saying holds. Owe your banker £1000 and you are at his mercy; owe him £1 million and the position is reversed" The EU has to deal with the monster it, itself allowed to exist, so no excuses for Germany and its friends.

Europe should own up to the limits of what is possible. This should have happened when the Euro was introduced. It was a flawed set of treaties from the start.

A zebra doesn't change it's stripes. The northern Europeans, especially Germany, view with disdain any individual, group, or country which lacks discipline and abidance by rules. They always have and always will. It is a fantasy to think they will do otherwise.

Unfortunately, I doubt if Greece will become anyone's ward, especially the IMF. The IMF will require austerity. Enough of the Greeks view any body enforcing rules as some terrible beast. They are capable of amazing emotional deflection and self disillusioning. It is part of their political psyche. As the Economist once stated, Greece is not only the cradle of democracy, but the cradle of drama as well.

Why are you punishing us with your CAPS and bad grammar/spelling. Your argument is without logic. Seriously? blame Germany. They are the ones bailing the Greek nation out. The people of Greece need to step up and take responsibility for their OWN finances. You need to live within your means and the people of Greece need to pay their taxes, its their civic duty.

It is obvious that everyone messed up on this project. The Greeks with their uncompetetive economy and lack of responsible governance and the designers of this project-yes, germany being the main engineer for allowing this to happen in spite of the obvious differences. I think pointing fingers would accomplish nothing at this point but acceptance and searching for the most optimum wayout of this mess for all parties.

The fact that a BSc Warwick and MSc LSE person does not have sound arguments to support his view is quite disappointing I have to admit. Instead on spending your time writing down posts full of empathy and lacking arguments you should do a bit of research on how much greeks work and what monthly salaries they receive. Additionally you should do a bit of research on what salaries germans receive. The employees working for the state do receive 13 salaries per year and the private sector employees usually get a Xmas benefit!
As for the repayment of the loans you should be aware that the EU was never designed and hopefully will never end up granting loans to member states and being anxious as to when the money will be repaid. Instead is based on a member-states support concept and now it is Greece that has the need for support. Of course I am not claiming that the loans should not be repaid, or that Greece should receive support eternally. There are a lot of mistakes Greeks has committed all these years, mistakes for which they now suffer politically, socially and economically.
I guess you are German, so I urge you to study a bit of history. When you find out what is the amount of war claims for damages owed by the German government to the Greek people you will think twice before writing such texts. And finally, when you do a small research on what is the percentage of Greek military spending that the German government receives you will find out that a big part of the loans granted to Greece result to be German revenue - most of the times on overpriced military equipment! This could be food for though on whether the EU has not only the role of the good big supportive brother but has started also showing signs of hypocrisy.

"Democracy in Egypt and Libya..." What have you been smoking lately?
Good idea, let's bring in the military to restore order and discipline.
But perhaps not the Greek military.... we need a good Truppenübungsplatz anyway.

Why are you punishing us with your CAPS and bad grammar/spelling. Your argument is without logic. Seriously? blame Germany. They are the ones bailing the Greek nation out. The people of Greece need to step up and take responsibility for their OWN finances. You need to live within your means and the people of Greece need to pay their taxes, its their civic duty.

Germany is the only country in the EU which does not have a homegrown democracy.

Democracy was imposed on Germany by outsiders under foreign occupation.

If it reaches a boiling it is more likely Germany that will turn to a Putin style autocratic rule if German parties don't listen to the people's opposition to more bailouts, not Greece, Portugal or Spain which after all have homegrown democracies.

As repugnant as it is, the Generals within the Greek military need to step in and take the reins of power. This allows the Economists to do what MUST be done. Within the scope of a plan ( somewhere b/w 3-7 yrs.) to an orderly transition back to democratic rule.

This will save Greece and the EU. Greece will emerge stronger and more competitive. This is not without historical precedence. The EU and the world will have to swallow hard but tough decisions must be made.

No path is with peril. Notwithstanding, this path will restore a great deal of confidence; what needs to be done will be done. Further, it will expedite the process of getting Greece's house in order.